Episode 5: Ian Taylor provides an update on the U.S.-China relationship

Why is the U.S.-China relationship so important to the global economy?

Ian [0:50] The U.S. and China are the two largest economies in the world. Combined, they represent somewhere in the neighbourhood of 40% of global economic output, depending on how its measured. And along with Europe, they make up the vast majority of global output and perhaps more significantly, global trade.

The trading relationship between the U.S. and China is massive. China is the largest trading partner of the U.S. with over $650 billion in U.S. trade volume bilaterally. The trading relationship is heavily tilted towards U.S. imports from China, totaling more than $550 billion, and most of this in goods as opposed to services. Since China was introduced into the World Trade Organization in 2001, U.S. imports have risen 427%. So, this is a key relationship on a global scale.

The US-China relationship is back in the headlines – why has the relationship worsened over the last few months?

Ian [1:44] Well, prior to the COVID-19 virus outbreak, tensions between the U.S. and China were softening. Entering into 2020, both sides were looking to stabilize their economies after an arduous 18-to-24 month trade war, in particular, as the U.S. election came in focus later this year. This was highlighted by the tentative signs of a phase one agreement in late 2019, with China reportedly agreeing to purchase $200 billion in U.S. goods and services and the U.S. agreeing to rollback, but not remove, tariffs that were introduced during the disagreement.

Then we had the COVID-19 outbreak that has resulted in tens of thousands of deaths globally, and the virtual shutting down of the global economy in an unprecedented fashion. Now, what is clear is that the virus outbreak emanated from China. However, as pressure mounts on the U.S. administration, for potentially being slow to react, there’s been an increased focus on China’s role in the spread of the outbreak, and whether more could have been done to alert global authorities. Obviously, this is a sensitive issue given we are in the midst of a pretty severe health crisis and inherently it will be highly political.

Add to that, the recent introduction by China of a national security law, while bypassing Hong Kong’s parliament. This anti-sedition law is another step by China to rollback Hong Kong’s autonomy under the one country, two systems’ model. And conditions are now ripe for re-escalation of tensions as a result,

Given the scope of the relationship, what could change if things continue get worse?

Ian [3:17] I think this only acts to amplify the tensions between U.S. and China longer term. You know, this really started to accelerate with the 2016 election, where U.S. President Donald Trump made it a key issue in his election platform.

You know in 2018, it accelerated first with China outlining its 2025 strategy, whereby it seeks to become a leader in a number of areas of technology. So, think robotics, infotech, aerospace and medical devices. And this was almost immediately followed by the introduction of tariffs by the U.S. on imports from China, and increasingly so over the next, you know, 18-to-24 months.

Now with the U.S. election in focus, it again is going to be a key part of both parties’ election platforms and maybe even more so, depending on the success of the economic re-openings. You know, the trade deficit was a fairly blunt tool used to highlight the perceived inequity of the relationship with China back in 2016. And it is probable that the circumstances around the virus outbreak may be wielded in the same fashion.

What are our expectations for the U.S., for China and the relationship going forward?

Ian [4:30] There are a lot of polarizing issues right now on a global scale and the continued rise of China and its continued challenge of the U.S. as the preeminent power globally. it’s going to be for the global economy. From a purely economic standpoint, there’s a lot of impetus to try to smooth things out as they did in 2019, given the fragile state of the global economy.

But the biggest risks to this view are if it becomes clear that the democrats become clearly favored to win the U.S. election, which may lead to more extreme measures by the current administration, as well as the ongoing situation in Hong Kong.

Longer term, regardless of which U.S. political party retains power following the elections later this year, this issue will remain at the forefront. While there is scope for some positive announcements along the way, like we saw towards the end of 2019, the polarizing nature of this relationship will undoubtedly lead to more conflict.

China has no choice but to try and move up the value chain as its old model of growth simply will not work in the future. And its citizens demand continued improvements in quality of life, and this will naturally lead to further tension with the U.S., as the country becomes more competitive on a global stage.

Given those insights, have we made any adjustments to our strategy?

Ian [5:42] There are a number of changes we have made to our portfolios over recent years with consideration to a growing influence of China on a global scale.

From a strategic standpoint, and think, you know, over a 10-year investment time horizon, we’ve increased our allocation of global stock markets relative to Canada. And that includes both U.S. and international developed markets, but also emerging markets.

One thing I would note is that the nature of emerging market stocks at the index level has changed substantially over recent years and will continue to do so going forward. It used to be just about BRIC countries – Brazil, Russia, India and China – but more and more, as China continues to expand and move away from more commodity intensive growth, it has become more focused on China itself, and emerging Asian stocks overall.

As I mentioned, we increased our allocation to both U.S. and international developed stocks as well. And a number of companies in these regions are very well positioned to benefit from the growth in emerging markets, and in particular, the emerging market consumer.

On a more tactical basis, we have been underweight emerging market stocks since 2018 in most of our portfolios. As trade tensions weighed on growth and investor sentiment towards the region, U.S. dollar remains strong creating a headwind to funding in these regions. Overall, given the prominence of both U.S. and China, it’s impossible to make investing decisions on a global basis, without giving at least some consideration to the impact of these two countries.

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